By Edward Kleinbard
As Republicans take on tax reform, they seem hell-bent on repeating the tactical mistakes they made during their attempts at health-care reform. Again GOP policy makers have cloistered themselves to develop a bill whose prospects will hang by a thread in the Senate. Yet there is a powerful bipartisan grand bargain in corporate tax policy waiting to be struck.
Democratic and Republican policy makers agree that the corporate tax system is irredeemably broken. They even concur on the broad direction of a replacement system—lower rates and fewer loopholes. But the two parties are far apart on the most important issues in corporate tax reform: what exactly the new corporate tax rate will be, and whether companies can write off their business investments in the year those investments are made.
Democrats are stuck at a corporate rate around 28% and do not want to permit full expensing of all capital investment. House Speaker Paul Ryan’s original “blueprint” for reform featured a 20% corporate rate and a tax on imports, the border-adjustment tax. Companies would lose the ability to deduct interest, but could write off their business investments in the year they’re made. These moves would eliminate the distorting effects of taxes on decisions about how much to invest and how to finance those investments, but expensing reduces revenue and does not by itself translate into a lower effective tax rate.
To reset the competitiveness of the U.S. tax system, corporate tax reform must be permanent and revenue-neutral. The $1.5 trillion in incremental deficits just approved by the Senate would actually cut into growth, because interest costs on new debt crowd out private investment. Senate parliamentary rules also prohibit permanent legislation that adds to the deficit from being passed by a simple majority. That’s why the border-adjustment tax, which would raise an additional $1 trillion a year, was a centerpiece of the original blueprint—and why its early death was so significant.
Republicans are between a rock and a hard place. Growth comes from a permanent low corporate tax rate, not one that expires in 10 years. The GOP should embrace a new revenue-raiser that can attract moderate Democrats without undercutting the economic benefits of reform. The answer? A carbon tax, which raises revenue, satisfies long-term economic efficiency and environmental goals, and is as important to Democrats as corporate tax rate reduction is to Republicans.
Most Republican politicians hate the idea of a carbon tax, even though some distinguished conservatives, like Arthur Laffer and George Shultz, support it. And progressive Democrats would never agree to revenue-losing corporate tax reform. Both sides should hold their noses and work toward major corporate tax reform financed in part with a carbon tax.
The Congressional Budget Office and staff from the Joint Committee on Taxation concluded in a 2016 report that a tax of $25 per metric ton of carbon would raise about $1 trillion over 10 years, neatly filling the hole left by the death of the border-adjustment tax. What’s more, economists from all political persuasions agree that a carbon tax is a well-targeted response to the long-term “externalities” of carbon emissions.
Earlier this year Democratic Sens. Sheldon Whitehouse and Brian Schatz proposed a trade along these lines, but their plan is politically infeasible. They want a carbon tax rate that starts at $49 a ton and ratchets up annually, and their suggested 29% corporate tax rate is unresponsive to the needs of Republicans and many business leaders. This doesn’t mean a deal can’t be reached. The parties need to embrace face-to-face negotiations—not Republican leaders holed up in the White House trying to get corporate tax reform done without a single Democratic vote.
An attractive grand bargain is waiting to be struck across two vitally important policy issues. Who knows? Perhaps working together along these lines will remind leaders in both parties that real legislative progress requires accepting some policies you find distasteful, to accomplish goals that are nearer to your heart.
Mr. Kleinbard, a law professor at the University of Southern California, was chief of staff of Congress’s Joint Committee on Taxation (2007-09).